Precious Metals Stocks - Is The Rally Really Over?

Prime Minister Gordon Brown, who will face a tough battle in the upcoming
elections, has two nicknames in the British press -- "Golden Brown" and "Goldfinger
Brown."

Since anything pertaining to gold is of interests to us at Sunshine Profits,
we looked into why the Prime Minister has such monikers. Does he perhaps have
a Midas touch?

It turns out that quite the opposite is true.

Brown, who took over from Tony Blair in 2007, acquired the ironic nicknames
about 11 years ago when, against the advice of leading bankers, he sold off
about 60% of Britain's centuries-old gold reserves. The timing of the sales,
from 1999-2002, was "impeccable." In his role as Chancellor of the Exchequer
he sold 400 tons at rock-bottom prices. He got an average price of $275 an
ounce, raising $3.496 billion. (British gold traders have dubbed the 20-year-low
the "Brown Bottom.") Since the unfortunate sale, gold prices have more than
quadrupled to $1,159 an ounce.

There is a lesson to be learned here both for nations and for individual investors--hold
on to your physical gold and don't worry too much about governments selling
or "dumping" gold when its price gets very high - history suggests that governments
are not the best traders and not necessarily sell at the top.

With only 310.3 tons of gold left in its Central Bank holdings, Great Britain,
once an empire that ruled half the world, ranks number 16 on the list of gold-holding
nations, just below Venezuela and just above Lebanon.

There is further irony in the fact that it was Britain that had led the way
in establishing a gold standard when Sir Isaac Newton, as warden of the Royal
Mint, linked the value of raw gold to the value of money back in 1717. The
1844 Bank Charter Act formalized the gold standard, the Bank of England's promise
that every note could be redeemed for its value in gold. The gold standard
lasted until Britain was forced to abandon it during World War I. Churchill
returned to the standard in 1925 but it was again abandoned in 1931.

Newspaper accounts in the British press estimate that Brown's gold sale cost
the British taxpayer about 6 billion pounds.

The gold sale has become a campaign issue and already posters have appeared
of a smiling Brown with the accompanying text: "I lost 6 billion pounds selling
off Britain's gold. Vote for Me."

According to British newspaper reports, the proceeds from the gold sale were
invested in dollars (40%), in euros (40%) and in the yen (20%). It is safe
to say that the revenues generated from the fiat currencies don't come close
to the spectacular four-fold increase in the value of gold since the sale.

In May of 1999, when Brown announced his plans to sell the gold, the price
had stagnated for much of the decade in a secular bear market. British gold
simply sat in the vaults gleaming prettily but earning no interest. Some had
perceived it as a capital wasteland, an anachronistic relic. Apparently, Brown
wanted assets that would generate interest payments. He ignored gold's habit
of retaining its intrinsic value over the long term.

"Golden Brown" was wrong to dump gold in favor of paper currencies. Gold's
breakout against the world's primary paper currencies underscores gold's growing
allure as a store of value against further currency debasement caused by profligate
government spending. It appears that gold is reassuming its role as an alternative
currency unencumbered by the political liabilities of fiat money.

Therefore, the long-term bullish
fundamentals are still in place despite the fact that governments still
own a substantial amount of gold - they are not super-traders, who are likely
to sell everything at the top, thus pushing prices lower. Still, fundamentals
are responsible for where markets go in the long-term (years), not where
they may go in the short- and medium-term (days, months). Therefore, let's
focus on the charts (charts courtesy by http://stockcharts.com)
and see what they tell us at the moment.

In the following part of this essay, we will focus on the situation in the
mining stocks, as it seems that there are several voices saying that the rally
in gold stocks is over and they are likely to decline from here - we respectfully
disagree.

In one of the previous
commentaries, we've stated that though sharply moving higher recently,
[HUI Index] appears to be ready to pause, especially, as the multi-month
support level has been touched. Consequently, the current pause is something
natural, not necessarily a signal of a coming plunge. One of the questions
at this point is - are prices likely to move much lower?

Let's take a look at the short-term GDX ETF chart, which we use as a proxy
for the PM stocks.

Only a few days ago the chart suggested that we were to expect the resistance
level of 49 to hold as the upper point with an expected support at $47 and
even more likely $46. The above levels were based on the Fibonacci retracement
levels, which have proven to be a very reliable signal as far as the precious
metals stocks are concerned. Consequently, the recent move lower is something
that one would expect to see as a part of a bigger rally, and doesn't seem
to signal a severe plunge.

Additional confirmation of the above points comes from the analysis of the
Gold Miners Bullish Percent Index - a market breadth/momentum indicator that
is calculated by dividing two numbers: the amount of gold stocks on the buy
signal (according to the point and figure chart, which emphasizes strong moves
while ignoring small ones) and the amount of all gold stocks in the sector.

We have featured the above chart also in the April 2nd, 2010 Premium
Update, when we wrote the following:

The high-probability sell signal is given if this index moves higher, and
both indicators (RSI and William's %R) used on the above chart become, and
then stay overvalued for some time. The initial overbought signal is marked
with the vertical dashed black lines, and the top signal is marked with red
lines. The overbought signal was given several days ago, so the probability
that the top is already in is relatively high.

Still, taking a more detailed approach, we see that if we get this signal
at the beginning of a rally, the top is likely to be formed in about two
weeks. That was the case about a year ago, in May/June 2009, and in September
2009.

Consequently, we have just seen a local top, which - once again - was something
that was likely to take place and does not necessarily signal a severe decline
at this point.

Summing up, while the first part of the rally in PMs and corresponding
stocks is over, there are no clear signs that the whole rally is over at this
point. Comments regarding short-term, and action that we believe is best to
take at this point are available to our Subscribers.

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Przemyslaw Radomski, CFA (PR) is a precious metals investor and analyst who
takes advantage of the emotionality on the markets, and invites you to do
the same.

His company, Sunshine Profits, publishes analytical software that anyone can
use in order to get an accurate and unbiased view on the current situation.

Recognizing that predicting market behavior with 100% accuracy is a problem
that may never be solved, PR has changed the world of trading and investing
by enabling individuals to get easy access to the level of analysis that
was once available only to institutions.

High quality and profitability of analytical tools available at www.SunshineProfits.com are
results of time, thorough research and testing on PR's own capital.

PR believes that the greatest potential is currently in the precious metals
sector. For that reason it is his main point of interest to help you make
the most of that potential.

As a CFA charterholder, Przemyslaw Radomski shares the highest standards for
professional excellence and ethics for the ultimate benefit of society.

Disclaimer: All essays, research and information found above represent
analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates
only. As such, it may prove wrong and be a subject to change without notice.
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